John McFall’s article for the Guardian. Read this on the Guardian website.
The magnificent setting of Mansion House is usually a place for gentle self-congratulation from the chancellor of the day on the economic achievements of the government and the financial industry. With the global financial crisis, that hasn’t been the case for the past few years. But on Thursday evening, Mansion House took a further dramatic twist with the pronouncements from the chancellor and the governor of the Bank of England.
Gone was Plan A, the last rites had been read for Project Merlin, and the modest reforms proposed by Sir John Vickers to make banks safer were severely diluted, to the author’s dismay. With what the governor called “dark clouds” on the horizon from Europe and an “ugly picture” in sight for the British economy, the UK’s banks were given their own cash machine on Threadneedle Street with an exclusive and private pin number.
Why this latest panic move by the government? Depressingly, the UK shares with Italy, alone among the Eurozone countries, the distinction of being in recession. With no growth prospects, banks and businesses holding on to their cash, and a million young people out of work, education or training, the government has had to ditch its Plan A for austerity. It was blindingly obvious from day one that no political party could succeed with the “austerity alone” slogan. Inevitably, death follows. The only way that can be avoided is by providing people with hope.
So now, with certainty in society and the economy waning, the government has drawn up a hasty and incomplete Plan C for confidence. It is centred on one idea: that by unshackling the banks, they will surge forward with new lending, spurring the economy on to growth.
If the long-term stability of the banking system is to be secured, the architecture needs to be properly constructed. That was a task that the chancellor gave to Sir John Vickers’ independent commission on banking.
But on Thursday evening the chancellor announced that these modest proposals to ring-fence and stabilise banks would be watered down even further. The proposed minimum level of equity capital for banks was reduced from just over 4%, as recommended by Sir John, to 3%. This may seem an innocuous change but as Martin Wolf, a member of the Vickers commission, has written, this “leaves these institutions horribly undercapitalised”, and means that the taxpayer is still on the hook in the event of a major failure. Excessive leverage was at the centre of the 2007 global financial debacle, and that is why Wolf is sensibly arguing for 10% as the ultimate equity requirement.
Meanwhile, the Bank of England will provide a discreet new credit facility, permitting the banks to withdraw up to £5bn a month on the basis of lower-quality assets than were previously accepted. In addition, a new “funding for lending” scheme will provide an unspecified level of cash for banks to lend to their customers (a vague target of £80bn has been mentioned).
So the focus of the authorities has clearly shifted from the long-term stability of the system to the need to grant the banks immediate room to begin lending. But will this latest strategy work? Have the banks been holding on to their cash and refusing to lend? Or have businesses and others so little confidence in the future of the economy that they are unwilling to borrow any money?
Hector Sants, the departing chief executive of the Financial Services Authority, has said that banks are hoarding cash rather than lending it, such is their lack of confidence in the economy. The banks retort that there is little demand for more credit from households or businesses, again as a result of their lack of confidence. The Treasury and the Bank of England wish the banks to retain the risks of any lending to the real economy, so given UK banks’ track record of holding on to this money, will it get to those who most need it? No doubt the banks will be grateful to the Bank of England for the extra wriggle-room they have been given, but there will likely be no increase in lending unless confidence can be improved.
George Osborne has still to address the growth problem. He will have to come forward with more proposals in the next month or so to stimulate growth. If he is to succeed, he will need to heed the comments of the IMF’s Christine Lagarde that if growth fails to pick up in the UK, the government will have to consider “policies to bolster demand before low growth becomes entrenched”. If he is sensible, he will start with policies that address youth unemployment, investment in infrastructure and temporary tax cuts. This would demonstrate that the government was at last beginning to “get it”.